The OECD has publicly called for both fiscal and monetary tightening by “2011 at the latest”:
“Exit from exceptional fiscal support must start now, or by 2011 at the latest, at a pace that is contingent on specific country conditions and the state of public finances,” the OECD said. “The normalization of policy interest rates should commence in most OECD economies in the course of this year.”
We can only assume that OECD now stands for the Organization for Economic Contraction and Depression, as this is the same policy prescription that worked such wonders for Japan during its two lost decades.
As we’ve pointed out in prior writings, the surest way to normalize monetary policy is to enact a concerted (and well designed) fiscal expansion. This could include tax cutting, public sector spending, or ideally, some combination of both.
Instead, there’s a rising drumbeat from many (unfortunately) influential quarters that insists on a double whammy of fiscal and monetary tightening. However, we can almost guarantee that with such an approach, interest rates will fall back to their near-zero levels in short order, as they did repeatedly in Japan.
Thank God for Christina Romer:
Christina Romer, head of the White House Council of Economic Advisers, said in Paris Thursday that it would be a mistake for the U.S. to rapidly wind down stimulus measures to bring down the deficit.
It’s not clear whether her boss’ party is listening to her. While they are telegraphing tax hikes and budget tightening, they’re also finding plenty of ways around PAYGO, according to Republican Rep. Paul Ryan. Under some conditions, that would be a bad thing. Under current conditions, it’s not. But unfortunately, as long as both parties continue to parrot the argument that the federal budget is like that of any state, business, or household, then whatever fiscal expansion does manage to slip through is far more likely to be suboptimal.
In 1971, Robert Mundell, an intellectual mentor to Ryan’s old boss Jack Kemp, wrote, ”The Keynesian model is a short run model of a closed economy, dominated by pessimistic expectations…“ He also claimed that, “This model is not relevant to modern economies.” (Monetary Theory, 1971)
We think that’s due for a reassessment. In 1971, with Germany and Japan recovering rapidly from the damage wrought by WWII, Japan about to embark on a very favorable demographic shift, and other Asian countries joining the global economy, Mundell’s statement was correct, even for the stagflationary U.S. But since 1989 in Japan, and 1999 in western economies, negative demographic shifts on top of burst credit bubbles have certainly fostered conditions of slow to no growth and increasingly pessimistic expectations. And if the Robert Mundell of 1971 had seen recent empirical analyses of population age composition, he might have dropped the “short run” part of his statement.
In other words, policymakers need to accept that Keynes is back, and disclose to their constituents why that is not such a terrible thing. Hayek’s time will come again, but not for another decade or so.
Political leaders would also do well to stop the many mouthpieces of the “neoliberal consensus” from desperately shoveling dirt onto the timely revival of Keynes and some of his succesors.